For China, Economic Hard Landing Unlikely

It is not hard to find a China hater out there. They argue about the lack of transparency. The housing bubble. The bad loans by government banks swept under the rug. The unrealistic currency peg of the yuan vs dollar. Chopsticks. You name it. Investors either love China, or they hate it.

Cong Li, a PhD in economics and chief investment officer at Mirae Asset Global Investments in Hong Kong, a $3.3 billion money management firm, tells Forbes that talk of a hard landing of the Chinese economy is unwarranted. China isn't perfect, but a Western style housing and banking crisis is not going to happen in the world's No. 2 economy.

The Chinese economy is slowing, much of it at the will of the government. The rest of it due to a lousy U.S. and European economy. Then again, 7% growth instead of 10% growth is a soft landing, not a hard one for China, Li says.

China has been a growth story for global equity investors for decades. In good years, it tends to outperform and in bear markets it will underperform. After this round of financial crisis, together with the stimulus packages, inflation has become a major concern for China’s equity market. Core inflation is likely to peak later than expected, and the Purchasing Managers Index, or PMI, has shown signs of a slowdown.

In August, inflation softened to 6.2% from 6.4% in July, while the PMI increased 20 basis points to 50.9. "We believe the domestic macro condition is improving," Li says from his office in Hong Kong. "Inflation is under control and a hard landing is unlikely. China is going through economic transition and its GDP growth is expected to be lower than previous periods going forward. But the volatility which has confronted domestic demand increases and industry upgrades will begin to decline significantly in our opinion. Therefore, the huge swing of investors’ expectation between overheating and hard-landing will gradually decline in the months ahead."

Fundamentally, China is in a much better position than most of the big emerging markets, and is better off than the U.S. and Europe. The recent collapse of global equities was triggered by increasing global macro risk, especially concerns about a slowdown in U.S. economic growth and the European sovereign debt crisis. Going forward, if the U.S. and Europe do enter a “double dip” recession, China’s export sector could take a hit in the near term, Li says. "The medium term impact on China’s economy, however, could be less because the Chinese government has flexibility on fiscal and monetary policies. China can reverse or unwind the tightening policies they have been implementing and thereby provide more fiscal support, such as subsidies to key industries and consumers."

Moreover, the moderation of the PMI is mainly due to monetary tightening rather than export weakness. China has been raising interest rates all year in an effort to curb inflation. China’s exports are slowing, but overall they have had a good run again this year. Exports are up 23.6% year-over-year through August even as the trade balance shrinks to $93 billion during the first 8 months of the year from $104 billion last year. Much of that can be blamed on domestic demand for imported goods and higher cost of raw materials, like iron ore.

China's GDP growth in the first half was a high 9.6%, the best of the big emerging markets. Growth has been driven by capital formation, consumption and only marginally by net exports.

Household consumption accounted for 34% of total GDP in 2010 compared to just 4% from net exports. There is a fundamental shift going on in China, even if the technical trade is killing the MSCI China index and the FTSE China Xinhua 25 (FXI) exchange traded fund this year. The stable increase of domestic consumption will be the pillar for economic growth going forward and secure against a hard landing, Li says.

Industrial production growth is up 14% YTD. Retail sales growth was up 17% for the first eight months of 2011. The CPI has already declined to 6.2% from 6.5% in July. With commodity and energy prices stabilized, together with effective monetary tightening policy, the CPI could drop by 1-1.5% to 5-5.5% in early 2012. Therefore, China’s government could have more flexibility to loosen monetary policy to avoid hard landing.

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The big cities like Shenzhen, Beijing and Shanghai are having serious housing troubles. Prices are out of control. A greater portion of income is going to pay for mortgages this year than last. But on a national level, Li says he sees no housing bubble. Government pressures on the sector is forcing prices lower. In some cities, prices might drop 5-15%, Li estimates. Unlike in the U.S., there is mortgage backed securities bubble to pop; and China isn't going to foreclose on properties. "There is no credit crisis," says Li. The loan-to-value ratio is lower than 70%.

China might not be crash landing, but is it a buy?

Indicators signaling a “buy” for China in the short term depend on the global liquidity condition stabilizing on any positive progress from Europe and the U.S. fiscal front; China’s inflation moves to a more comfortable level, say about 4-5%; and if the overhang is removed for the property market.

What about the impact of more quantitative easing in the U.S.? For Li, it's a mixed signal. In the previous two rounds of quantitative easing, the Fed simply bought more U.S. debt to inject liquidity into the economy and it now owns $1.65 billion of government bonds. The impact of monetary expansion was short-lived for the recovery of the economy, while corporate spending was stagnant and global inflationary pressure heightened due to the rising commodity and food prices. This time, however, the Fed is trying to provide economic stimulus without expanding its balance sheet. Because this activity by the Fed is likely to create less inflationary expectations, this “buying-time” measure could be slightly positive for China in the short term, Li says. Nevertheless, China's success is still at least partially pegged to U.S. demand.

"The recovery of the U.S. depends on the deleveraging process there, which leaves uncertainty of external demand for China’s goods," he says.

I've spent 20 years as a reporter for the best in the business, including as a Brazil-based staffer for WSJ. Since 2011, I focus on business and investing in the big emerging markets exclusively for Forbes.